Why You Should Make an Emergency Fund a Priority

However, before your temporary escape from a hectic life, you have to plan that vacation.

You spend hours looking up hotels, places to eat and things to do but it doesn’t feel like work because the anticipation of this trip makes you feel happy.

Unfortunately, we’re not putting the same level of effort for major financial necessities, especially for something as important as an emergency fund. Shockingly, according to The National Foundation for Credit Counseling, 64 percent of Americans don’t even have $1,000 in their savings to cover an unexpected event, such as an emergency room visit.

It’s understandable — no one looks forward to emergency situations that would cost a ton of money.

So, we’re less likely to build an emergency fund even if we have the money to do things like go on vacation. In fact, many Americans actually choose not to build an emergency fund even though they have the financial wiggle room to do so.

Fortunately, the power to change that mentality is within our grasp. I will show why an emergency fund is critical and how you can save for an emergency fund without a lot of thinking or effort.

What exactly is an emergency fund?

An emergency fund is money that is saved up for the purpose of covering the costs of unexpected situations such as a sudden illness, loss of income or car repair.

As if an emergency isn’t scary enough, the majority of bankruptcies in America are actually caused by medical bills.2 Having this fund will prevent a financial emergency from becoming a financial disaster.

The most common question is: how big should your emergency fund be? Generally, it should be equivalent to 3 to 6 months worth of living expenses, which includes housing, utilities and food.

For example, if your monthly living expenses total $2,000, your emergency fund should have $6,000 to $12,000 in it.

To give you an idea of how long it would take to build a $6,000 emergency fund, check out the table below:

Monthly Savings

Emergency Fund Goal

Months to Complete Goal

$200

$6,000

30 months

$400

$6,000

15 months

$1,000

$6,000

6 months

Obviously, the more you can funnel into emergency savings, the sooner that you’ll have that financial buffer. (If you already have some money in savings, then congratulations on getting a headstart on your emergency fund.)

How to prioritize your emergency fund when money is tight

Many people are understandably confused as to how they should prioritize their emergency funds when they also have to consider other financial obligations, such saving for retirement and paying down debt.

We believe that an emergency fund is the absolute #1 priority. Without an emergency fund, you’re going to have to borrow money to pay for an emergency and end up interest payments that will likely keep you in debt.

Therefore, after you’ve paid the necessary monthly bills and minimum payments to your credit cards and loans, start putting money towards your emergency fund. Once the emergency fund is fully established, then you can focus on these other financial goals.

Savings accounts are the best choices for emergency funds because they’re safe places for your money, they’re easy to access and they pay interest. (Don’t focus too much on interest rates though — your primary goal here is to accumulate savings.)

When an emergency hits

By not planning for life’s random emergencies with a rainy day fund, we are setting ourselves up for financial turmoil.

If you’re one of the 64 percent of Americans who lack $1,000 to cover something like an emergency room visit, the following table will be an eye-opener for you.

These are some common options you could use to pay for a $1,000 medical bill:

Cash Alternative

Typical Cost

Major Pro

Major Con

Sample Cost of $1,000 Borrowed + First Month's Interest

Credit card cash advance

2-5% fee + 24.99% APR

Cash is available immediately at any ATM

Cash availability is subject to your credit card limit

$70.83

401(k) loan

5% APR

Interest is paid back to the 401(k)

Pay 10% tax penalty + taxed at current tax rate if you don't repay on time

$204.17-$500.17 (if you don't repay on time)

2-week payday loan

$15 fee per $100 borrowed

Easy to qualify for

High interest rates usually make it hard to eliminate the debt

$150 (effective APR of 390%)

Emergency Fund

$0

No need to take a loan

Takes time to save money

$0

Without an emergency fund, these alternatives are able to get you the money you need to cover the expense.

However, look at the hefty cost that you’ll pay for not being prepared financially.

With cash advances and payday loans, you are faced with ridiculous interest rates that are likely to keep you swimming in debt.

With a 401(k) loan, you might get a low interest rate, but you’re going to pay hefty taxes and penalties if you have trouble repaying the loan (you usually have 60 days to repay the loan if you’re no longer employed).

Contribute to your emergency fund without thinking about it

Frankly, we know it is tough to make it enjoyable to create an emergency fund. Remember, emergency funds take some time to set up. If you’re dragging your feet, automate your finances.

Pick an online savings account. Go with an online savings account for higher interest rates, plus most of them don’t have monthly fees.

When you’ve established your emergency fund, it doesn’t mean you should stop saving.

Go ahead and use the same method for all your other savings goals. Tip: try separate automatic transfers for each individual goal. (We know that online banks like Ally Bank and Capital One 360 let you create multiple savings accounts, so you can nickname each account for each goal.)

Building an emergency fund is just the beginning.

By eliminating much of the work required to save every month, you’ll eventually discover that it isn’t all too hard to stay focused on your financial goals.

Simon Zhen is a research analyst for MyBankTracker. He is an expert on consumer banking products, bank innovations, and financial technology.

Simon has contributed and/or been quoted in major publications and outlets including Consumer Reports, American Banker, Yahoo Finance, U.S. News – World Report, The Huffington Post, Business Insider, Lifehacker, and AOL.com.

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Many of the savings offers and credit cards appearing on this site are from advertisers from which this website receives compensation for being listed here. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). These offers do not represent all deposit accounts and credit cards available. Credit score ranges are provided as guidelines only and approval is not guaranteed.